What, markets can go down too?

Today is the start of these newly-found daytraders getting flushed out of the market.

What has happened is that apparently half of the cohort of unemployed people have entered into the casino known as the stock market with their unemployment/CERB cheques (this is a bit hyperbole – $2k isn’t going to move the market too much, but when you consider $43 billion in CERB has been handed out so far, not a trivial amount of money!), signed for accounts on RobinHood and WealthSimple, and suddenly turned into stock market geniuses buying shares of companies in Chapter 11. This is a by-proudct of many factors but very loose monetary policy is one of them. When you couple this with every institution on the planet trying to get into equities because they can’t make a return on their fixed income portfolios anymore, you will have days like today where the people with less conviction get flushed out.

Throw in a spooky headline like this:

Second wave! Second wave! Fear the second wave! Must sell because the news is bad!

Anyhow, this is why I suggested to lighten up last Friday and take some chips off the table.

This isn’t going to be a one day thing, the effect of flushing people out of the market involves having sharp down days (people getting caught long), and sharp up days (people getting caught in cash). This process rinses and repeats until monetary policy eventually kicks in, swamps the whole system with liquidity, and this gets pumped into the asset markets once again. Things are a lot faster than they were 22 years ago when this sort of thing happened in 1998 after the LTCM bust, but I’d guesstimate a week or two before the flush is completed.

I’m going to use Hertz as an example.

Visualize this. The equity of a company like Hertz (Chesapeake, Pier 1, etc., you name it) is fundamentally going to zero after it restructures out of Chapter 11. They have a fixed number of shares outstanding that are trading, and they have to be somewhere. Just because people sell it doesn’t mean the shares vanish – they are transferred to somebody else. The same goes for the cash. The only difference is that the asset value (the stock) changes.

Any sane institutional manager (I am not talking about the day traders, or high frequency traders that would have a rational reason to be purchasing the stock, but this would be for a very short term period) would have dumped out on Hertz equity if not on May 26th when Chapter 11 was announced, but they would have been guaranteed to bail out by June 8th, where there were 523 million shares traded and the stock topped out at over $5/share. Keep in mind that Hertz has 142 million shares outstanding!

So this leaves the question of – who the hell would want to own the stock after this? The institutional demand for Hertz equity will be zero – they are all cashed out and not interested in getting in. The answer has to be retail investors, where currently (at a share price of $2.10 as I write this) US$300 million of client capital is locked up. There will be some other retail investors that look at the chart, not even realizing what Chapter 11 means, and purchase the stock, and some of these retail investors will be able to get out, but you can be sure that the only bids you will be receiving will be of other retail investors, or short sellers covering the trade. (Edit: Or perhaps the RobinHood/WealthSimple brokerages simply are making a mint speculating off of their clients by selling any Hertz their customers buy and then they have a very cheap borrow!)

In these ‘flushing’ processes is that after it is done, the garbage of the market will lose asset value, while the entities that have value will later receive a wave of demand – aided in part with the cash from their sales of Hertz at US$5! The people remaining will be true bagholders, and will eventually flip the stock around to a diminishing pool of demand until it gets cashed out at zero once the Chapter 11 process is completed. The inevitable result – wealth gets transferred – from the buyers of worthless Hertz to the sellers, who will move the asset value into something (presumably) more productive.

Torstar insider trading before NordStar acquisition announcement

The Globe and Mail is reporting potential insider trading that went on before the acquisition announcement of Torstar (TSX: TS.B).

I posted above this possibility the day after the announcement.

It is pretty obvious from my eyes that there is something worth investigating, albeit the dollar values involved were relatively tiny. The transactions are so obvious that anybody conducting trades like they did were not sophisticated enough to know the liquidity of the stock was like trying to squeeze water out of lava rocks – you can look at the trade history to see it did not take a huge amount of volume to move the price up.

My guess, if there was some insider trading going on, was that some receptionist or office worker saw some prominent individuals (e.g. Rivett and/or Bitove) walk out of an office and then he/she tipped off a friend, who then pumped a bunch of market orders into the TSX, in a very unsophisticated manner.

Tailored Brands – not looking too good

The next clothing retailer that stands a good chance of going to Chapter 11 (to restructure what are fairly onerous amounts of outstanding store leases) is Tailored Brands (NYSE: TLRD).

They filed Form 8-K today and the salient highlights are this:

Cash and cash equivalents at the end of the first quarter of 2020 (this would be May 2, 2020) were $244.2 million;

…

As of June 5, 2020, cash and cash equivalents were $201.3 million, excluding $93.5 million of restricted cash.

That’s a burn rate of about $43 million per month, which should be disturbing to most investors, especially since they have a minimum cash maintenance requirement with their lender.

In order to reduce the cash burn, they need to sell inventory and get their stores up and sell product. However, initial data does not look good:

The Company noted that it is too early to determine steady-state comparable store sales for the second quarter but wanted to provide an update on recent performance. For the week ended June 5th, for stores open at least one week, the average comparable sales performance was:

o Men’s Wearhouse down about 65%,
o Jos. A. Bank down about 78%, and
o K&G down about 40%.

Clearly buying suits hasn’t been a priority of the consumer public post-Covid-19.

Ignoring the common stock, which has been exceptionally volatile over the past week (it spiked up to US$2.40 two days ago, and is now closed at $1.24), the corporate debt tells the real story:

This is the July 1, 2022 unsecured debt, with US$173.4 million outstanding. It is structurally behind the majority of the company’s asset-backed loan facility which does not bode well for recovery for the unsecured debt. If you have any inkling that the company will make some sort of financial recovery, however, these bonds are trading at roughly a 100% YTM at present.

A sure sign of Chapter 11 will be if the company decides to withhold interest payments on this debt (we will find out by the end of June), or they could be pulling the plug earlier than that. Who knows, with how Hertz (NYSE: HTZ) has traded after its Chapter 11 filing, it might result in an improvement in the stock price!

A side note – famed “big short” investor Michael Burry took his lumps on the stock last month. At one point he had a 4 million share position (8.3% of the company), with his last shares purchased in March 24, 2020.

I have no positions in TLRD or its debt, and not intending on taking one – they need to chop off half their debt, shed half their leases and this can only come in the form of a restructure within Chapter 11. I made my trade for a few cheap suits after they cut their dividend to zero, and closed it out late last year for a mild gain.

Market observations

The S&P 500 is up another 100 points today, purportedly on a jobs report that the US hired people in the month of May (everybody was expecting layoffs). For example, the unemployment rate expected was 19.8%, while the actual rate was 13.3%. Suffice to say this was a shock.

So everything’s going crazy. Cruise liners are up about 20% (they’ll be able to raise another round of financing and sail through it). Energy stocks are going through the roof. There are all sorts of indications of a market recovery, and indeed, the “V” scenario happened:

Recall my daily rule of “only sell in up markets, buy in down markets”. There will be days things will go down, that’s the time to buy. On a day like today, the only real option is to lighten up and raise some cash. You’re too late if you do the opposite. Today, and especially for those in the past month, those that have cash on the sidelines are hurting. The only worse feeling in the stock market than losing money is to watch everybody else make money while you’ve got a pile of zero-yielding cash. The news headlines are going to gravitate away from Covid-19, protests and now gravitate towards recovery and give people a feeling of comfort. Again, this will be false, since it will be built up on a pile of debt taller than Olympus Mons, but this is a medium term consideration and not short-term, which will be euphoria.

You are also seeing the start of the capitulation of the gold market, which is down about $40 per ounce. Although the downside here is not going to be extreme (10-20% from the US$1,780 peak?), holders in gold will be wondering alongside those holding cash whether they should dip back into the markets at ever increasing prices. There will be a significant contingent of people holding on to hedge themselves against the excesses of monetary policy, but there are also a lot of “loose” holders that have held paper gold which will want to catch the equity train. In fact, for those contemplating dipping back into gold, consider that the Canadian dollar is likely to rise in the future due to the resurgence in commodities, so valued in Canadian dollars you will probably be able to pick up gold for relatively less.

In these sharp rallies, there are going to be two-three day periods where you will see volatility spikes and the main indexes will dip down, usually caused by some transient headline. These are really the only opportunities to deploy cash. The only factor is when they will happen – it is difficult to predict these sentiment spikes. These spikes down are designed to wash out very short-term holders (this tend to be retail investors very new to investing that are skittish to volatility and because they tend to act in swarms, it amplifies price changes), but the overall trend is going to continue to be up as long as Central Bank rocket fuel propels the market.

Speaking of which, by the end of this year, the Federal Reserve is going to step off throwing gasoline onto the fire, and depending on how ridiculous things get, may even signal an increase in interest rates next year (the buzz-word will be “re-normalization”, very ironic since nothing is normal now). Any rate increase will be nothing extreme – just a quarter point – but even they will start to recognize when the S&P 500 hits 3500 that they should be applying some brakes otherwise they are getting ready to engineer the market crash of the 21st century that will make the 2008-2009 economic crisis look like a correction. Central Bank interest rates cannot rise too much because there is just too much debt.

My last note is a very easy prediction. Zoom stock (Nasdaq: ZM) in three years will be lower than US$208/share. The borrow is extremely cheap right now, but once the Federal Reserve rocket ship stops, this is probably the easiest short candidate I have seen in ages. I wouldn’t short it now because all of the index-based buying can make it even more ridiculously expensive. But I did note that Zoom sent me a spam to my inbox offering me 30% off a yearly subscription (I was month-to-month) and this is more than their usual “buy 12 months for the price of 10” offer, which means that their management is smart enough to know their gravy train is ending, and ending soon (get the years’ worth of deferred revenues while you can!). Microsoft, Google, and even open source options are all competing for this market and Zoom has little in the way of competitive advantage other than incumbency protection.

Have a good weekend everybody.

Taking my foot off the market accelerator

When reading the news, keep in mind that it is trying to program your brain what to think about. Frequently it tries to program your mind how to think. Social media is a filter and amplifier of both of these effects.

In all of these instances, they do not give you any cues about what is not being discussed. As a result, the potential for availability bias is extreme if one does not have reasonably decent critical thinking skills.

I’ve written before about what it takes to outperform in the markets, and one variable is knowing where your thinking is standing in relation to the competition. Since a good amount of the competition is programmed by media what to think, there is a value in paying attention to the programming, but with keeping your full mental shields on.

Right now, apparently Covid-19 is no longer the scourge of the earth. Businesses are re-opening, a good chunk of the public is in silent defiance of social distancing, and life appears to be slowly getting back to normal, short of the annoying lineups you see to get into Costco.

A safe time to invest back in the markets again? Seemingly yes, but the process of transitioning from a very risky (Covid-19 is going to kill us all) to risky (riots in the name of racism is going to kill us all) to not so risky (normalization of the pre-Covid life) has more or less been priced into the market – the S&P 500 is sitting at about 8% less than the pre-Covid peak.

Short of these headlines (riots, normalization), what is not being discussed? I’ll leave this as an exercise to the reader. Being able to assemble ideas to answer the “not” question is valuable in that it allows you to take a good guess at what might be in future headlines (presumably after you’ve gone long on whatever it is that you’ve thought of).

After things re-open, there is a certain ‘novelty’ factor which will result in an initial boost, but reality will be setting in pretty soon – the Canada Emergency Response Benefit payments will end (the US parallel is the $600/week unemployment benefit enhancement), and then decisions will become tough. This will come with increased risk, which portends to choppy waters ahead.

I’m not saying we’re going to crash back down again, but I am saying that the ‘easy’ gains (at least if you recognized that March 23rd was indeed the bottom) have been made here and things going forward will be much more difficult than the past month. The past month you could throw you money into nearly anything and make profits, while going forward, the market is going to be much more discriminating. In particular, I’d be especially hesitant to be long on stocks that Robinhood investors are bullish on. With record amounts of retail account openings, it gives me caution (although the wisdom of the masses may be correct in that they want to be converting their cash into assets that aren’t going to depreciate rapidly like all world currencies are doing).